RFP’s May Increase Risk and Costs

by Krishna on November 30, 2008

Paul Graham makes a great point in his essay about how every risk management tactic by an organization has a cost. He explains how these costs are greater than they seem at first glance, because they filter out competence for doing tasks and replaces it with competence at selling. I would like to elaborate on vendor selection, which was one of his examples.

Many governmental agencies, large corporations and, to an extent, smaller organizations are fond of issuing RFPs (Request for Proposals) for selecting vendors for projects they wish to source out. The reasoning behind the RFP process is simple. It is to provide news of the project opportunity to prospective vendors and the wider public (including public interest activists). All vendors are provided the same public information and given a fair chance at bidding for the project, thus avoiding any corruption or favoritism. Usually, the vendor selection criteria and weights are also published.

For all its claims of good intentions, the RFP process followed by many organizations is badly flawed. Many RFP’s are poorly written with information totally inadequate for project estimation purposes. Organizations usually hold a vendor conference and are available for questions, but these too provide little additional help. Many vendors decide not to bid for the project because of the prospect of getting the estimate wrong. Others, to compensate, will add a huge risk premium to the project cost.

If vendor selection is primarily made on project cost, there is a high chance that the selected vendor under-bid the project. This opens up several possibilities. One is that the vendor tries to cut corners on the project, thus under-delivering on the requirements. Or they try to adhere to the promises and go out of business, thus killing the project. Or they come back at some point during the project, asking for more money.

If vendor selection considers other criteria too, it is more likely that the organization is paying a high premium for the cost buffer that the vendor has built in. Why is this so? The selected vendor has usually done projects of a similar nature (hence their selection) and knows the ballpark figures for the project costs. They then add sufficient margin to the upper bound of those costs so that they don’t run the risk of a loss.

The typical response to this criticism is more documentation-heavy RFP and/or a multi-step RFP. For example, a first step could be a simple RFP that asks for vendor capability and then winnow the unqualified vendors. Then the remaining vendors could be provided detailed technical information and then provided a chance to bid on it more accurately.

While this is an improvement, it ignores the fact that the RFP process is very expensive for both the organization and vendors. The whole operation can take months from the creation of the RFP to the vendor selection. During this period, the organization is involved in preparing the RFP, releasing it, answering questions, reviewing responses, interviewing vendors and selecting a final vendor. The vendor has to spend time understanding the RFP, sending follow-up questions, attending the vendor conference and subsequent interviews, and reviewing the final contracts (which can run into several pages).

The organization’s cost is huge but hidden, because loss of opportunity due to employees spending time on busy work is always invisible. The selected vendor’s expenses are part of their proposal, but no one ever realizes this because customers always think that they are paying for the product, and never overhead such as the salaries of salespersons. The cost incurred by the rejected vendors is gone. If a vendor loses a few of these RFP’s, they quit bidding for future RFP’s, even though they may be highly qualified. Over a period of time, you can see how this works out. The vendors who quit are not those who do a bad job of executing the project, but instead, those who do a bad job of obtaining the project.

For very large projects (especially for military needs), the imperfections of the RFP process pale in comparison with the risks of failure. But many organizations issue RFP’s for smaller, non-critical projects, where the expenses can eat significantly into any cost savings (for the organization) and any profit (for the vendor). Now, as I mentioned before, organizations use RFP’s to improve transparency and impartiality. But when the project is smaller, any potential cost savings by eliminating favoritism is very small and quite possibly even eliminated by the RFP expense.

Cronyism is not that much of a problem at a lower level, because, in many cases, no-bid contracts follow market rates. Prices cannot be set at so exorbitant levels that it invites attention. The sponsor has an interest in the success of the project to avoid being blamed or fired for selecting an incompetent vendor. By tightening the process and making it a committee-level decision, no one is accountable for the vendor selection, thus reducing direct oversight of the vendor performance.

So, if your organization is into long-winded RFP’s, think twice. You may be risking and losing a lot more than you think.